Is a Debt Jubilee the Next Big Meme?

The idea of a "debt jubilee" -- that is, a wide-spread forgiveness of debt
as a way to reset the US financial system -- has been bouncing around for
a while. But it hasn't gained mainstream traction because it seems, at first
glance, to be too simplistic to be worth serious thought. It must have a fatal
flaw that would jump out as soon as one looks at it, which makes looking a
waste of time.

But the idea keeps bubbling up, so the other day I finally decided to try
to understand it. And the story, as with most apparently simple things, is
more complicated and harder to dismiss than it seems at first.

According to Wikipedia, "The concept of the Jubilee is a special year of remission
of sins and universal pardon. In the Biblical Book of Leviticus, a Jubilee
year is mentioned to occur every fiftieth year, in which slaves and prisoners
would be freed, debts would be forgiven and the mercies of God would be particularly
manifest."

Note the fifty-year cycle, which is not that far from the 60-year Kondratieff
Wave, at the end of which debt is forcibly erased through mass default.

The problem with the classical jubilee concept is spelled out by Martin Hutchinson
and Robert Cyran in a 2011 New York Times article:

The
Downside to a Debt Jubilee
Good ends do not justify bad means. That philosophical observation applies
to proposals for a big American debt jubilee that are now doing the rounds.
The basic idea is to slash consumer debt, which is an admirable aim for
an overleveraged nation. Household debt is still 90 percent of gross domestic
product, down only modestly from the 2008 peak of 100 percent. But even
bank-haters should recognize that this cure might be worse than the disease.

To start, writing off debts would not necessarily increase economic growth.
Every liability is also an asset, so while a dollar that is no longer required
for debt repayment might add some cents to consumer spending, it is also
a dollar cut out of a bank's capital or of an investor's net worth -- subtracting
from resources and confidence.

And write-offs big enough to change consumer behavior would probably be
big enough to destabilize banks. The Federal Reserve or the government
would need to help, presumably by injecting newly printed money as capital.
Such government control is usually inefficient, and abundant printing of
money increases the risk of uncontrolled inflation, which has its own way
of making people feel poorer.

The issue of moral hazard also cannot be ignored. Much of the excess debt
was incurred through irresponsible mortgage refinancing, which peaked in
2006 at $322 billion, representing 2.4 percent of G.D.P. The reckless use
of houses as A.T.M.'s was a major factor in decapitalizing and destabilizing
the American economy. Forgiving such debts will teach the wrong lesson:
borrow in haste, repent never.

Finally, investors would rightly see a jubilee as an attack on property
rights. That runs the risk of throwing markets into disarray and discouraging
foreign investors from buying assets in the United States. Risk premiums
on both debt and equity capital would increase.

There are better ways to deleverage. Higher inflation does the job more
naturally, without invidious choices about whose debt got reduced. But
inflation also discourages savers, weakening capital formation. The best
way to get debts under control is the hard slog of paying some back and
writing the rest off.

Sound money, including interest rates above inflation, would help by preserving
existing capital and promoting savings. After all, capital creation, not
its destruction through debt forgiveness, is what makes capitalism work.

The fact that one person's debt is another's asset does seem to be a concept-killer.
But in the ensuing year several jubilee proponents have proposed updated versions
that address this flaw. Jump to minute 17 of the following interview with
Australian economist Steven Keen for his proposal. In a nutshell, he thinks
we've reached a debt "event horizon" where we can't grow fast enough to escape
the pull of deleveraging. His solution is a kind of quantitative easing for
the masses, where the Fed gives individuals newly-created dollars with the
requirement that they pay off their mortgages and credit cards.

And then there's the mounting federal debt held by the Fed. Consider this,
from a DollarCollapse.com reader:

John,

As an average guy that has accumulated a small amount of wealth over the
last 30 years of working and saving, I am terrified as to what may lie
ahead. I read Dollar Collapse daily and also have read tons of information
from guys like Jim Rodgers, Peter Schiff, Gerald Celente, Charlie McGrath
etc. And while what all you guys say makes perfect sense to a "work / save
/ spend within your means" kind of guy like me, I am seriously wondering
if we are really going to go down the path you guys all prescribe to.....hence
the reason for this note. I hope you will indulge me and maybe even answer
me back as I really am terrified and not sure how to proceed.

Specifically, what if the powers that be have another form of "exit/reset" of
the system that guys that think our way don't see? So I propose this hypothesis...

If the Central Banks of the World become the lender of last resort and
take on more and more and more of the percentage of sovereign and business
debt....why can't they just "forgive" all those loans when things get really
bad? I mean ultimately they were loans out of thin air anyway. They just
wipe out the loan, and take the whole thing off of their balance sheet...wouldn't
it actually strengthen the remaining dollars? It may sound far fetched,
but why would they "reset" the system, when they can just "forgive the
loans" reset everything back to zero and in the end still have the dollar
and still have control of the money.

Now we've entered some interesting territory, and as with so many financial
things, the difference between traditional and "modern" is the introduction
of fiat currency. In past debt jubilees, money was real, and debt could only
be forgiven if the other side of the balance sheet was likewise affected.
The debtor's gain was the creditor's loss, which meant no net gain in societal
wealth.

But with fiat money so much of the financial system is fictitious that it
opens up some new possibilities. The Fed is currently buying the majority
of the debt issued by the US government, which in effect means the government
is lending itself money (yes, the Fed was created as a private institution,
but in recent years it has effectively merged with the Treasury and the military/industrial
complex to form a single globe-spanning empire. It's all one thing now.).
So what would be lost by different branches of the fiat currency monolith
simply zeroing out some bookkeeping entries? Just like that, the "national
debt" shrinks by a third or more. Hmmm...

Same thing with the quantitative-easing-for-individuals idea, in which dollars
are created out of thin air and passed to the banks, via the banks' customers.
Individual debts fall, bank loans are converted to cash, and systemic net
worth increases by the amount of debt that's eliminated.

This probably won't happen, and would be profoundly immoral if it did. But
because a modern electronic printing press makes such alchemy possible, it
will be seductive to a desperate society that's been shaped by the idea of
voting for free stuff. So expect to see the jubilee concept become a topic
of mainstream debate we drift closer to Keen's debt event horizon.

John Rubino edits DollarCollapse.com and has authored or co-authored five
books, including The Money Bubble: What To Do Before It Pops, Clean
Money: Picking Winners in the Green Tech Boom, The Collapse of the Dollar
and How to Profit From It, and How to Profit from the Coming Real Estate
Bust. After earning a Finance MBA from New York University, he spent the
1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst.
During the 1990s he was a featured columnist with TheStreet.com and a frequent
contributor to Individual Investor, Online Investor, and Consumers Digest,
among many other publications. He now writes for CFA Magazine.